Yes, the poor do set up small businesses. They may be efficient, but are they profitable? Abhijit V Banerjee and Esther Duflo study the economic choices of the poor and find that they are rational but imperfect. A book excerpt
A businessman sitting next to us on a plane many years ago described how, when he returned to India in the mid-1970s after completing his MBA in the United States, his uncle had taken him out for a lesson in true entrepreneurship. It was early one morning when he and his uncle headed for the Bombay Stock Exchange. But instead of going into the modern tower that houses the exchange, his uncle wanted him to observe four women who were sitting on the sidewalk, facing the road in front of the exchange. The aspiring businessman and his uncle stood for a few moments watching them. The women mostly did nothing. But occasionally, when the traffic stopped, they would get up, scrape something off the road, and put it in plastic carrier bags next to them, before returning to their seats. After this happened several times, the uncle asked him if he understood their business model. He confessed to be baffled. So the uncle had to explain: Every morning before dawn the women went to the beach, where they collected wet sea sand. They then laid it evenly on the street before the real traffic began. When the cars started driving over the sand, the heat from their wheels dried it. All they had to do then was occasionally to scrape off the top layer of sand, now dry. By nine or ten, they had a quantity of dry sand, which they brought back to the slum to sell in small packets made from discarded newspapers: The local women used the dry sand to scrub their dishes. This, the uncle reckoned, was true entrepreneurship: If you have very little, use your ingenuity to create something out of nothing.
Women from slums who manage to make a living, quite literally, from the wheels of Bombay’s commerce epitomize the incredible spirit of innovation and entrepreneurship the poor often display. [...] Such images have been a powerful motivation for the recent microfinance and “social business” movement, which starts from the premise that the poor are natural-born entrepreneurs, and we can eradicate poverty by giving them the right environment and a little bit of help getting started. [...]
Muhammad Yunus, founder of the world-famous Grameen Bank, often describes the poor as natural entrepreneurs. Combined with the late business guru C K Prahalad’s exhortation to businessmen to focus more on what he called the “bottom of the pyramid,” the idea of the entrepreneurial poor is helping to secure a space within the overall anti-poverty policy discourse where big business and high finance feel comfortable getting involved. The traditional strategies of public action are being supplemented by private actions, often taken by some of the leaders of the corporate world (for example, Pierre Omidyar of eBay), directed at helping the poor realize their true potential as entrepreneurs. [...]
There are, however, two troubling shadows in this otherwise sunny picture. First, while many of the poor operate businesses, they mainly operate tiny businesses. And second, these tiny businesses are, for the most part, making very little money. [...]
The entire stock of a shop we visited in the outskirts of the town of Gulbarga in northern Karnataka, about a five-hour drive from Hyderabad, consisted of largely empty plastic jars in a dimly lit room. It did not take long to take inventory:
Inventory of a General Store in a Village in Rural Karnataka, India
1 jar of savory snacks
3 jars of soft candies
1 jar and 1 small bag of wrapped hard candies
2 jars of chickpeas
1 jar of Magimix instant stock
1 packet of bread (5 pieces)
1 packet of papadum (a snack made from lentils)
1 packet of crispbread (20 pieces)
2 packets of cookies
36 incense sticks
20 bars of Lux soap
180 individual portions of pan parag (a combination of betel nuts and chewing tobacco)
20 tea bags
40 individual packets of haldi powder (turmeric)
5 small bottles of talcum powder
3 packs of cigarettes
55 small packets of bidis (thin, flavored cigarettes)
35 larger packets of bidis
3 packs of washing powder (500 grams each)
15 small packs of Parle-G biscuits (cookies)
6 individual-size packets of shampoo
During the two hours we spent with this household, we saw two customers. One bought a single cigarette, the other a few sticks of incense. Clearly, the marginal return of increasing the size of the inventory a little was potentially extremely high, especially if the family could try to buy something that the other shops in the same village did not supply. But the overall return of the activity was very low: With this volume of sales, it was not really worth the time spent sitting in the shop all day.
This is the paradox of the poor and their businesses: They are energetic and resourceful and manage to make a lot out of very little. But most of this energy is spent on businesses that are too small and utterly undifferentiated from the many others around them. As a result, their operators have no chance to earn a reasonable living. The creative sand-driers of Mumbai had spotted an opportunity to make a profitable use of the resources available to them: some free time and the sand on the beach. But what the businessman’s uncle had failed to point out was that, for all their ingenuity, the profits from this activity were almost surely negligible.
The very small scale of many of these businesses explains why their overall returns are often so low, despite the high marginal return. But it brings to light a new puzzle. The fact that marginal returns are high means that it is easy to grow the overall returns — just put more money into the business. So why aren’t all the small businesses growing really fast?
One part of that answer we already know — most of these businesses cannot borrow very much, and what they can borrow is very expensive. But this is not the whole answer. First, as we saw, although there are millions of microcredit borrowers, there are many more who have the opportunity to borrow but choose not to. Ben Sedan was one of them. He had a business raising cows and could have grown it with a microcredit loan, but he decided against it. Even in Hyderabad, where there are several competing MFIs [microfinance institutions], the sign-up rate for any microcredit loan among families who were eligible to borrow was only 27 percent, and only 21 percent of those who had a small business had taken a microcredit loan.
Moreover, even those who cannot borrow can save: Consider the shopkeeper family in Gulbarga. They lived on about $2 per day per person. In nearby Hyderabad, our data show that those with this level of consumption spend about 10 percent of their total monthly expenditures on health care, whereas those living on less than 99 cents a day spend about 6.3 percent. If, instead of spending an extra 3.7 percent of his budget on health care, our shopkeeper had used it to build up his inventory, he could have doubled his inventory in a year. Alternatively, the family could cut down completely on cigarettes and alcohol and save about 3 percent of their daily expenditure per capita: This would allow them to double their inventory in about fifteen months. [...]
If our diagnosis is correct, the reason that the poor do not grow their businesses is that, for most of them, it is too hard: They cannot borrow to cross the hump, and saving up to get there will take too long unless their businesses have extremely high overall returns. [...]
The fact that most micro-entrepreneurs may not be fully committed to making every penny count may also explain the disappointing effects of the business training programs that many MFIs have now started proposing to their clients as an added service. At weekly meetings, clients are told about how to keep better accounts, manage their inventories, understand interest rates, and so forth. Programs of this kind were evaluated in studies in Peru and India. The research results in both countries found some improvement in business knowledge but no changes in profits, sales, or assets. These programs are motivated by a sense that these businesses are not particularly well run, but if the businesses are run that way because of a lack of enthusiasm rather than a lack of knowledge, it is not particularly surprising that the training does very little to help. [...]
Taken together, this evidence makes us seriously doubt the idea that the average small business owner is a natural “entrepreneur,” in the way we generally understand the term, meaning someone whose business has the potential to grow and who is able to take risks, work hard, and keep trying to make it happen even in the face of multiple hardships. We are, of course, not saying that there are no genuine entrepreneurs among the poor—we have met many such people. But there are also many of them who run a business that is doomed to remain small and unprofitable.
Excerpted with permission fromRandom House India
POOR ECONOMICS
A Radical Rethinking of the Way to Fight Global Poverty
Authors: Abhijit V Banerjee and Esther Duflo
Publisher: Random House
Pages: xii + 306
Price: Rs 499
